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Greetings, and welcome to the Equity Commonwealth First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host Sarah Byrnes, Vice President of Investor Relations. Thank you. Ms. Byrnes, you may begin.
Thank you, Doug. Good morning and thank you for joining us to discuss Equity Commonwealth's results for the quarter ended March 30, 2018. Our speakers today are David Helfand, President and CEO, David Weinberg, COO; and Adam Markman, CFO.
Please be advised that certain matters discussed during the call may constitute forward-looking statements within the meaning of Federal Securities Laws. We refer you to the section titled Forward-Looking Statements in yesterday's press release as well as to the section titled Risk Factors in our most recent Annual Report on Form 10-K for a discussion of factors that could cause actual results to materially differ from any forward-looking statements. The company assumes no obligation to update or supplement any forward-looking statements made today. We also post important information on our website at www.eqcre.com including information that may be deemed to be material.
Today's remarks also include certain non-GAAP financial measures. Please refer to yesterday's press release and supplemental containing our first quarter 2018 results for a reconciliation of these non-GAAP performance measures to our GAAP financial results.
With that, I will turn the call over to David Helfand.
Thanks Sarah. Good morning. Thanks for joining us.
I'll begin with brief comments on market conditions, review our first quarter results, and provide an update on the company's progress so far in 2018.
In the first quarter, the U.S. economy grew 2.3%, down from 2.9% in the fourth quarter of 2017. During the quarter, the economy continued adding jobs at a healthy pace of about 200,000 jobs per month and the unemployment rate remains steady through March at 4.1%.
Pace of hiring slowed a bit in April to 164,000 jobs added, though the unemployment rate fell to 3.9% the lowest level in 17 years.
Equity markets continue to be choppy with higher volatility, the REIT index is down 4.5% year-to-date underperforming the S&P 500 which is roughly flat and NASDAQ which is up about 5%.
Fixed income market has seen increases in key benchmark borrowing rates, 10-year treasury yield grow to 3% level in recent weeks for the first time since 2014. On the short end of the yield curve, one-month LIBOR is 1.9% up 35 basis points this year to a level last seen in 2008.
Turning to the office market fundamentals, things continue to be decent, demand is broad-based and has mostly kept pace with new supply, with the national vacancy rate of 13.3% at the end of the quarter, up 25 basis points since year-end.
Looking forward, the pace of deliveries in 2018 and 2019 is projected to exceed the pace of net absorption. While asking rates are up modestly, lease economics are more difficult given increased cost for tenant improvements.
With respect to real estate capital markets, office transaction volume declined by roughly 10% in the first quarter versus a year ago, continuation to the slowdown in transaction volume we've noted for the past two years. Despite declining volumes, we continue to successfully execute on our repositioning strategy by selectively selling assets where we can achieve attractive pricing.
The real estate debt markets remain robust, with numerous participants actively providing fixed and floating rate options, including banks; life companies debt funds, and CMBS. So far this year spread contraction has limited the impact of rising rates on all-in debt costs, while the 10-year treasury rate has risen 50 bps this year, spreads have contracted roughly 20 basis points.
Turning to our business in EQC, we continue to make progress on executing our plan. Year-to-date, we repaid $575 million of debt and invested $88 million in share repurchases.
During the first quarter, we leased 117,000 square feet and our leasing pipeline is healthy. In addition, April was a strong month for leasing and David will provide more color on that a little later.
Finally, as expected, same-property cash NOI growth turned positive this quarter, the results of our strong leasing execution in the past two years.
With respect to dispositions, in the first quarter we closed on the sale of three properties totaling 2.6 million square feet for gross sales price of $785 million. Two of these sales were previously disclosed. We sold 1600 Market Street and 826,000 square foot office building in Downtown, Philadelphia that was 85% leased. Gross sales price was $160 million, the pricing was in the 5% cap rate range. We also closed on the sale of 600 West Chicago Avenue 99% leased 1.6 million square foot building in the River North submarket of Chicago. The gross sales price was $510 million and pricing was in the low 5% cap rate range.
Finally, we closed on the sale of a 100% leased 249,000 square foot single tenant office building leased to Re/Max in Suburban Denver, Colorado. Gross sales prices was $115 million and pricing was in the high 6% cap rate range.
We currently have three properties totaling 1.5 million square feet in various stages of the sale process including 1601 Dry Creek, a 553,000 square foot building in Longmont, Colorado. 1601 Dry Creek was held-for-sale at quarter-end.
Additionally, we're in the market with 8750 Bryn Mawr, a high quality 636,000 square foot office building in Chicago's O'Hare submarket and we are marketing 97 Newberry a 289,000 square foot industrial building in East Windsor, Connecticut.
In total, we have sold almost $6 billion in assets in the past four years. We have used the proceeds to bolster our balance sheet, reducing debt and preferred equity by $3 billion. Our cash and marketable securities balance to-date, pro forma for debt repayment post quarter end is about $2.7 million. Potentially we transformed EQC from a disciplined group of average quality properties with our focus on operating platform into an integrated operating business with demonstrated execution capability. In doing so, we have significantly derisked the company. We now own high quality assets with embedded growth and value-creation opportunities in growth markets.
Our portfolio and balance sheet provide the option to grow off the pace of high quality assets and tremendous liquidity to pursue long-term value-creation opportunities. As a result of our disposition activity and mindful of the cost of managing our business, we recently reduced our staffing level to reflect the workload associated with the smaller portfolio. As a result, G&A was about $1.3 million higher for the quarter due to severance costs.
Our strategy will continue to be informed by market conditions but the real estate investment sales market has softened somewhat in the last couple of years, prices remain high by historical standard with low cap rates and projected returns and high prices per pound relative to replacement costs. Pricing environment to-date for high quality assets does not in our view lend itself to achieving superior returns and as a result we are being patient.
We will focus balance of the year on aggressively leasing and managing our assets, preparing select properties for sale, and exploring investment opportunities.
With that, I'll turn the call over to David.
Thank you, David and good morning everyone.
I will begin by reviewing our first quarter leasing activity and giving an overview of our largest markets. Then I'll cover our lease roll through year-end.
Our same-property portfolio was 88.6% leased at the end of the first quarter, down 60 basis points from the fourth quarter, and up 140 basis points year-over-year. Please keep in mind that as our portfolio has gotten smaller, there likely will be greater fluctuations in our leased occupancy.
For the quarter, rental rates increased 10.8% on a GAAP basis and 2.8% on a cash basis. The largest lease we signed in the quarter were 17 Street Plaza in Denver. We renewed a 22,000 square foot tenant. We also expanded into another 4,000 square feet. In the quarter, we signed 117,000 square feet of leases.
Leasing volume has since picked up and the second quarter has started much stronger. In just the month of April, we signed 238,000 square feet of leases consisting of 155,000 square feet of new leases and 83,000 of renewals.
Turning to our markets, Boston and Bellevue continue to be strong. The vacancy rate in Austin is 9.7%, a 176,000 square foot property in Downtown, Austin, 206 East 9th Street was 64% leased as of the end of the quarter. However, in April, we signed a new 26,000 square foot lease at this building which brings it's current leased occupancy to 78%.
The vacancy rate in Bellevue CBD is 9% and is expected to be even lower later this year. As we have previously said given the strength of this market and the quality of Tower 333, we believe this property is well-positioned for Expedia's lease expiration in December 2019. We continue to actively pursue new tenants in anticipation of this upcoming new route.
In the Philadelphia CBD, the vacancy rate is 12.1%. Our property 1735 Market Street is one of the premier office buildings in the city and the vacancy rate for trophy properties is under 9%. Most of the available space at this building is on its lower 40s and we continue to see good large prospect activity.
In the Denver CBD, the vacancy rate is 17.5% which is 220 basis points higher than last quarter. The vacancy rate is temporarily elevated due to the first quarter delivery of 950,000 square feet of new supply. These buildings are 79% pre-leased and tenants will start to take occupancy later this year.
As we have said on recent calls, leasing 17th Street Plaza has been challenging as we continue to compete with new construction. Denver is a very attractive city for Millennials and other well educated workers and we like this market over the long-term.
In Boston, we own a well located asset a few blocks from Fenway Park near the Longwood Medical District it's easy access to public transportation. 109 Brookline was built in 1915 and was formerly a Jeep factory. The 286,000 square foot building has a brick facade, 12 to 15 foot ceiling height and an above standard floor load capacity. It is 95% leased and current tenants include office, data center, and lab space users. The resurgence of the Fenway area has resulted in numerous nearby retail amenities creating a vibrant work lifetime end. It is unique asset that is very attractive to today's tenants and a redevelopment opportunity over the long-term.
In Washington D.C.'s East we own a 196,000 square foot well located office building at 1250 H Street. It has a unique core location with three-and-a-half size of glass line, providing tenants with an abundance of natural light. The building features a three level subterranean garage and we can strike with a new conference center, fitness facility and bicorp [ph]. The property is 85% leased and is good leasing activity.
Finally, I'd like to comment on our lease roll through year-end. The largest and I'll get back later this year is 40,000 square feet at 8750, Bryn Mawr, Chicago. This move up was addressed in April when we signed a 79,000 square foot, 20-year lease with Camozzi [ph] for its U.S. headquarters. The lease was a combination of nine months of work that include negotiating a determination to the other tenants to accommodate Camozzi's [ph] needs. The success we have had at 8750, Bryn Mawr is a good example of what we have been doing for the past four years. The turnaround of this property was a team effort including asset management, engineering, and investments. Two years ago the property was 89% leased and two large tenants since moved out. We had a significant amount of space to lease. To attract new tenants, we upgraded the properties amenities including creating a new tenant lounge in outdoor patio.
In addition to the lease with Camozzi [ph], at the end of 2016, we signed a new 87,000 square foot 15-year lease for the headquarters of First Midwest Bank. In total, we’ve signed 300,000 square feet of new leases at this property in the last 24 months. It is now 95% leased with a weighted average lease term of just under 10 years. We have fundamentally changed the profile of this asset and are marketing it to monetize the value that has been created.
At the end of the quarter, for the remainder of 2018, we had a 175,000 square feet rolling or 3.1% of our lease square footage. Of this amount we expect to get three quarters back. However some of this space has been recently backfilled.
Taking into account Camozzi [ph] and other April leasing, we believe there's approximately 85,000 square feet of space rolling that has not been backfilled and we are well-positioned to increase leased occupancy over the course of the year.
With that, I will turn the call over to Adam.
Thanks, David good morning.
I'll provide a review of our financial results for the quarter as well as an update of where we stand regarding debt repayments, taxable income, and share buybacks.
Funds from operations were $0.05 per share compared to $0.27 per share in the first quarter of 2017. The majority of the decrease is a result of asset sales. For the quarter, dispositions caused about $0.19 per share of the decline. Also notable was a book loss of about $4.9 million or $0.04 per share from the write-off of unamortized deferred financing fee related to the payoff of our 2042 bonds.
State and local income tax expense triggered by gains on asset sales caused an additional decrease of $2.8 million or $0.02 per share. FFO benefited from $0.04 per share of lower interest expense.
Finally, interest and other income grew by $0.01 per share, but netted from this line item is $0.04 per share or $5 million loss related to the sale of securities.
Normalized FFO was $0.14 per share compared to $0.24 a year ago. The decrease in normalized FFO was primarily due to dispositions completed over the past year, partially offset by interest expense savings from debt repayments, and an increase in interest income due to the combination of higher rates with higher cash balances.
Our same-property portfolio at the end of the quarter comprised 13 properties totaling 6.3 million square feet excluding 1601, Dry Creek which was classified as held-for-sale at quarter end.
Same-property net operating income was 2.1% lower in the first quarter compared to a year ago. The decrease was largely due to higher real estate taxes net of reimbursements primarily related to increases at 1735, Market Street in Philadelphia and 17th Street Plaza in Denver. The portfolio was 88.6% leased and 83.5% had commenced occupancy at quarter end.
Same-property cash NOI was 4.3% higher than in the first quarter of last year driven by higher rental income as several tenants completed their free rent periods. These gains were partially offset by tenant move out and the previously mentioned increases in real estate taxes.
Results for the quarter do not include $2 million of revenue from leases in free rent. Growth will also benefit from 326,000 square feet of signed leases which are not yet commenced and therefore are not in cash or GAAP NOI. These leases will eventually generate $11.7 million in annual rent, but it will take time before this flows through results.
In addition to future dispositions, we of course will be impacted by tenant move outs, but we anticipate solid cash NOI growth for the next couple of years.
Moving to dispositions, we sold $785 million of properties in the quarter. These sales generated a net taxable gain which exceeded our net operating loss carry-forward by roughly $150 million. As a result and for the first time, since taking control of the company in 2014, we expect to generate positive taxable income this year.
Turning to the balance sheet, we repaid an additional $175 million of 5.75% debt in the first quarter and last week we repaid the entire $400 billion balance on our term loans. These floating rate loans had an interest rate of 3.23% at quarter end. Including the term loans the total liabilities repaid over the past few years is now $3 billion including our Series E preferred. The liability side of our balance sheet includes just one $250 million bond due in 2020 and two small mortgages.
Our balance sheet remains strong with approximately $22 per share or $2.7 billion of cash and marketable securities following last week's term loan repayment. We have built significant capacity and are actively looking to put it to work to create long-term value. In the interim, we have been buying back our stock. We repurchased approximately 3 million common shares at an average price of $29.67 per share during the quarter.
Since 2015, we've invested $245 million buying back approximately 9 million shares at an average price of $27.61. We have over $130 million of share buyback optimization remaining. The liquidity and balance sheet flexibility that we built continue to be competitive advantages that position us well for future opportunity.
Thank you. And with that, we’ll open it up to Q&A.
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions].
Our first question comes from the line of Manny Korchman from Citigroup. Please proceed with your question.
Hey, good morning everyone. Adam the impairment on marketable securities that you mentioned, can you give us some more detail as to what that was related to and of the remaining marketable securities balance how much of that is in debt or bond instruments and how much of that is in common stock?
Yes, thanks Manny. So wasn’t an impairment, it was a loss and I will kind of walk through our securities position. From time-to-time we take positions in companies that we're interested in. In this case, we sold security that we had since the first quarter of 2017. We generated about $24 million in proceeds in March. That sale was at a price that was about $3 million less than what we paid for the shares in 2017, but the accounting hit was $5 million because the market value of the shares was above our purchase price at year-end as was reflected in the year-end balance sheet. And we don't currently hold any common stock, but from time-to-time we will.
Thanks for that. And then just in terms of the buyback you guys sort of reticent to do that earlier in the sales process but have done it now what change maybe in your approach or thinking or what parameters are you looking for when making that decision more specifically?
Well, just generally we opportunistically have been in the market for our shares, when we can. And as we mentioned in prepared remarks we've got an authorization of an additional $130 million and obviously we have plenty of cash. I guess my last point is that we've not had trouble getting the board support for incremental buyback authorization when it's been appropriate.
And David it’s Michael Bilerman so how much of the current securities balance today represents shares in other companies you may be targeting if any?
We don't currently -- yes, good question. We don't currently hold any common stock but as I mentioned before we may from time-to-time.
And so this was a $24 million proceed to $29 million -- a $27 million investment that was that you sold down to $24 million but had been marked up at the end of the year about a $5 million loss?
That's right. You got it.
So it went from $24 million to $29 million and then you sold it for $24 million, took a $3 million loss, but a $5 million GAAP loss.
That’s it.
And was this a company that you took a position in arguably you had discussions with and try to get a seat at the table or this was just sort of taking a position and hoping something would happen?
We're not going to get into detail on how far things line or what our purposes were but clearly we're not in the business of buying common securities except if there's a strategic purpose to doing so.
Our next question comes from the line of John Guinee with Stifel. Please proceed with your question.
All right, thank you. I'm just looking at Page 7 and you've got weighted average common shares year-over-year, looks like the basic went down by 200,000 but the diluted went up by 2 million value sold, 3.1 million shares, can you help us understand the math here?
Yes, that's related to our Series D convertible preferred shares. They're convertible into nearly 2.4 million common shares, so each of our earnings measures EPS, FFO or NFFO requires us to individually assess the dilutive impact of converting Series D preferred to common to determine whether to include those in the diluted share count. And then so this quarter largely due to the impact of the substantial gains on the sales of property and net income the Series D preferred was dilutive for EPS purposes but not for the purposes of FFO or NFFO where you exclude the impact of the gain on sale of properties.
So just to get a little more specific that Series D switched from as a dilutive to a dilutive at about $80 million of net income versus $186 million -- $187 million that we reported and this happened John before in the third quarter of 2014 the Series D were dilutive to EPS and FFO, but not the NFFO, so from time-to-time just again depending on earnings we will see that dilution.
A great segway into my next question, if you were to try to retire this $122 million, $123 million of preferred what would the cost be to EQC?
The shares can be retired at par if there's a change of control right or liquidation of the company is really when that would happen. Beyond that the shareholders have the option to convert at a share price north of $50 of share.
Our next question comes from the line of Jed Reagan with Green Street Advisors. Please proceed with your question.
Hey good morning guys. I think you previously stated the lease commencements would be sort of back end weighted this year is that still the case and I guess you're just thinking about sort of the pace of the cash same-store NOI growth for the rest of the year should we look for sort of that to continue ramping up?
Yes. We don’t provide guidance, but maybe I can give you just a little bit of help on the topic, really growth is coming from three sources, right it's the free rent that's getting used and then turning into cash, it’s signed but not commenced leases that are moving in and then any incremental leasing that we're able to achieve, so of those three most of the free rent piece will kick in before year-end.
The majority of the revenues coming from leases that are signed but not commenced will also kick in before year-end, but then remember those leases go into a free rent period, so the impact on cash NOI will be further out and then lastly, given our very measured role that David Weinberg mentioned earlier we're optimistic that we can generate positive growth on the leasing front.
Okay, that's helpful. Real quick on Longmont that sale under contract you need any position to give some clarity on pricing on that?
Not at this time as we've done in the past, if and when a deal closes we’ll provide more information afterwards.
Okay, fair enough and I guess related to that, so you’ve got couple more assets on the market. I think a couple lease-up properties which maybe characterizes being kind of more noncore market oriented and then you start cutting more into, kind of higher quality more target oriented markets as it would seem. Do you take a pause on sale once you've gotten through some of those more noncore type assets or the pace of sales continue unabated?
Well I would think the pace will have to slow down somewhat just given as we sit here today we own 13 properties, there is a fewer assets to take to market and as you described with the two on the market if you look at our property list there aren't many on the list anymore that you would think our obvious disposition candidates so it will become a much closer and more meaningful discussion around when is the best time to maximize the value of each of these properties, consider pricing, long-term growth opportunities and make decisions as we go.
Okay, that’s helpful and maybe just last one for me, as you kind of look around the land stay for opportunities out there today would you say your focus has shifted more to public opportunities versus private and as the -- I guess the flavor of deals you're looking at been evolving at all over time or it's been pretty consistent.
Hey Jed it’s David Helfand. I wouldn’t say our focus has changed, we try to look at everything we monitor public companies, we looked at private portfolios, we’re talking to large owners, I wouldn’t say there is a notable shift in where we’re spending our time.
Our next question comes from the line of Mitch Germain with JPM Securities. Please proceed with your question.
Good morning guys. I just I know there was potential for Expedia to do some sort of month to month or short-term renewal, is that out of the picture at this point?
Well, I’m not sure what you’re referring to Expedia doesn’t have any contractual rights to extend its lease. So it just have to depend on the facts and circumstances if and when that came to be.
Got it. I thought that they had approached you guys for some sort of short-term extension as the development still is underway?
No. We have conversations with tenants all the time.
Got it. And I just don’t understand next year’s lease roll, they’re in next year's or they in 2020?
So in the lease expiration schedule, they will be shown in 2020 because their expiration is December 31, 2019.
Okay. So the 14% expiring next year is other than Expedia, is the way to think about?
That is correct, they're improved 2019 and they show up in 2020.
And I know you’ve given some great color regarding the lease rolls over the course of 2018, is there anything that we need to be -- notable that stands out in 2019?
I’ll take a couple of minutes and walk you through the larger tenants, so as we published we have 643,000 square feet rolling in 2019 which is a 11.4% of our lease square footage. The larger tenant tend to be expiring later in 2019, I think on the last call, we talked about Georgetown while the asset is two buildings 240,000 square feet as noted and discussed. Georgetown subtenant extended through 2037 in 112,000 square feet. So Georgetown is only occupying 129,000 square feet. The lease expires September of 2019 and we’re talking to them.
The next largest is a 74,000 square foot tenant at Bridgepoint but as noted in our supplemental in a footnote in April we extended them for five years, so we address that role. The next largest is a 59,000 square foot tenant at 109, Brookline Avenue. They expire in August 2019, we expect them to vacate. And then the only other tenant larger than 50,000 square feet rolling in 2019 is a 57,000 square foot tenant at 1735 Market Street. Once again they don’t expire until October 2019 and we're speaking with them everything else is smaller and we are having ongoing discussions with most of those tenants.
Our next question is a follow-up question from the line of Jed Reagan. Please proceed with your question.
Hey guys, just a couple of small thoughts just related to leasing. On the Dry Creek asset, was that I think there was an expiration coming up this year, did that asset ultimately get kind of fully stabilized or did you end up selling that with a little bit of kind of near-term move out embedded?
No, I think it might have been last called one before that we talked about extending one of the larger tenants there as part of that extension, they are going to give that space, that space comes back I believe in July of this year and it has not been backfilled.
Okay, so just made more sense to sort of move forward rather than try to tackle that yourself?
Correct.
Okay. And then just mechanically Adam I think you had mentioned the positive cash flow income for the year, is that should we think of that in terms of kind of a one-time special dividend later in the year or potentially a recurring dividend starting soon?
We’ve always felt that the appropriate time for recurring dividend was when we add a stable portfolio generating recurring cash flow and given our disposition pace and the unique nature of what we’ve created here that if we are not at that point as we sit here today.
There are no further questions in the queue. I would like to hand the call back to management for closing comments.
Thanks for joining us today. We appreciate your interest. Have a good day.
Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.